More cuts to come for the RBA

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The RBA today cut their target for the overnight cash rate 25bps to 4.25%, in what was one of the more obvious moves of the last few years. Prior to the meeting, economists and journalists said it was a close call, but that’s not borne out by today’s statement.

You can see this from the outlook section. In contrast to the November meeting, the RBA left the outlook open: they did not try to characterise the policy rate as neutral / appropriate, and did not shape the outlook for future rate moves. They said only that they would keep moving their policy rate to “foster sustainable growth and low inflation”.

With both Chinese PMIs below 50 for the first time since H1’09, and a weighted average of our trading partner manufacturing PMIs headed still further below 50 in November, it seems clear that they would have been packing a lower forecast for global growth, and therefore a lower inflation forecast. If anything, I think they would be surprised by the speed with which the European recession has shown up in Asian data.

So what of the outlook? I think the bank will probably cut again in February – as I expect that Q4 CPI will again be sub 0.5%q/q.  As I am pessimistic about the European outlook I expect that there will be a few more cuts beside that on a demand basis.

The so-called resolution of Europe might help lower EU PIIGS bond yields, but these steps are bullish for Aussie yields. More rules for European budgets means tighter fiscal policy, which means less exports for Asia, and thus less export demand pull for Australia.

I am fairly sure the cash rate will be between 3.25% and 3.75% by the end of Q1’12, and I doubt that the AUD will be materially lower than it is just now. Watching how things have been trading, I suspect that we might find that the AUD heads to ~1.20 once we go ‘risk on’, despite the RBA cutting rates and the terms of trade falling somewhat.

A swiss move (to ~1.40) could force the cash rate down into the 2s in 2012-13.

The demand for AUD assets has the potential to do this. With the rest of the world being downgraded, the space of AAA rated Sovereigns is shrinking quite rapidly – and the consequent inflows into safe-haven Australian will prop the AUD up.

Our problem is going to be how we balance the very strong currency. The RBA is likely to react step by step as inflation remains very low: cutting 25bps following each sub 0.5%q/q inflation print. I think the most likely scenario is that the AUD appreciates once we go ‘risk on’ and that inflation remains very low and that the RBA cuts step by step as it becomes clear that inflation is stuck sub 2%y/y.


  1. In the medium term, I am still ‘optimistic’ that we will get a US recession. As John Hussman says, the economic consensus has never correctly anticipated a recession. If that happens, I think the AUD will go down to the 80s during the risk-off phase before rising again as we get some serious QE. But longer term, I agree – there is much less scope now for discretionary fiscal expansion and rates were lower to start with, so a cash rate with a ‘2’ in front of it seems quite possible by the end of 2012.
    Nudie run! Nudie run!

  2. If credit markets freeze as they did last time lower cash rates are academic.

    Banks will not be lending as they have littel funds to do so

  3. The AUD at 1.10 was the peak, it’s down form here (slowly). AUD at, or above, parity is simply not sustainable and the economy will continue to weaken until that lasts.

    Tip: visit or : you’ll see that EVERY single product (electronics, books, toys) is about half price there and even offers free shipping on certain items. That’s where people are buying and spending their Christmas money… and that’s why department stores in Australia are doing quite badly, even with population growing.


    1. tell that to the swiss. sometimes, it’s just about ‘other’ factors. You might make a case – apart from the better credit of Australia – based on the demand for our exports. Iron ore and coal will peak in about 5yrs, just in time for gas to really take off…

      1. Yes, my point is that a high AUD has a huge deflationary impact on the Australian economy… and its full impact can’t be fully appreciated now, it’s longer term.

        As you say, rates will need to get lower to target 2% to 3% percent inflation with such a strong currency (should the currency stay this high: a serious slow down in China would be a game changer).

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